Commentary on how China and the world are adapting to each other -- or not.

December 27, 2013

Levitt Condones US Influence-Peddling in China

Arthur Levitt, a former SEC Chairman, had a nice, consolling gift for American banks operating in China in the form of a Wall Street Journal op-ed on Christmas day. He catigated the current SEC leadership and other American regulators for going after JPMorganChase and other banks who hire the princelings of Chinese leaders in order to promote their businesses.

He justifies the practice in three ways. First, he says it is so commonplace in the US that it would be hypocritical to outlaw it in China. He writes:

The accusation is scurrilous and hypocritical. If you walk the halls of any institution in the U.S.—Congress, federal courthouses, large corporations, the White House, American embassies and even the offices of the SEC—you are likely to run into friends and family members of powerful and wealthy people...

Whether this is right or wrong, unfair or fair, is not the point. It is hypocritical of financial regulators to criticize—even penalize—practices abroad that are commonplace in Washington, New York and other seats of political and economic power.

Were the SEC to be completely consistent in its approach, it would have to come down hard on the same practices here in the U.S. And the agency would have a field day. Members of Congress and the executive branch regularly hire the children of major donors. Regulators would find scores of examples of men and women, occupying internships and entry-level positions in U.S. corporations, who were hired on the say-so of someone much higher up in the organization.

His second justification is that such hirings are critical for business success. You're more likely to get high-quality personnel based on personal recommendations, and such individuals are invaluable "assets" because of their connections.

His last criticism is that if we outlaw hiring based on personal ties, it would be impossible to know exactly where to draw the line. So don't, and allow any and all kinds of hirings.

Mr. Levitt's op-ed is galling for three reasons:

First, for the former head of the SEC to make these arguments runs against everything the US lectures China and other countries about with regards to their financial systems. And I use the word 'lecture' intentionally. US authorities have for decades lectured bankers and financial regulators in other countries that they need to root-out personal ties, conflict of interest, and corruption from their financial systems and have banks operate on a "commercial basis," that is, make loans and investments based on the commercial merits of the transactions and the credit worthiness of the borrowers. The US government, the EU, the IMF, and Western banks all pinned the Asian financial crisis on such personal ties, what has been termed "crony capitalism." And this perspective is what drove the IMF and others to attach extremely rigid conditions to their bailouts and forced extensive restructing of the financial systems across the region. And in case he forgot, the US just went through one of the deepest financial crises in 70 years, and we should recognize that some of the sources of the crisis lay in the cozy ties between our banks, investors, and regulators.

Given such lecturing and our own recent experience, it's beyond ironic that the Mr. Levitt is now arguing that such behavior should not only be permitted, but it should be encouraged and respected.

Second, I actually do not have a problem with hiring employees partly on lineage, nepotism, and connections. Financial markets are highly regulated everywhere, even more so in China, and getting through that maze of regulations takes people with knowledge of not only the written regulations but the people assigned to implement those regulations.

But it would be wrong to say, as Mr. Levitt does, that anything goes. Some hirings create a conflict of interest or the perception of conflict of interest. Whether opeating within the US or abroad, American banks should be required to avoid conflicts of interest whenever possible. Moreover, they should be required to disclose such conflicts of interest when they could potentially materially affect those who entrust their business to them. If JPMorganChase and others had not tried to hide these practices and been more open about them, perhaps the regulatory and public reaction would not have been so harsh. If these are acceptable -- and even honorable -- practices, then these banks should have no problem being more transparent about what they're doing.

Third and finally, just because influence-peddling is common within the US does not mean we should just allow it everywhere else. And just because it is hard to know where to draw the line doesn't mean we shouldn't try. We need to make America's rules more stringent and enforce them better, not simply throw up our hands and stick our heads in the sand while his banker friends run amok. This applies to all the various areas of financial regulation, from hiring practices to grey markets to credit ratings to insider trading. The US financial system is far from perfect -- Dodd-Frank fixed some things but made others worse and left some problems unaddressed -- and there are important areas of regulation at the international and trans-national levels that needs to be addressed.

So there is no need to be puritanical, but let's be reasonable and encourage practices that are not geared to helping powerful banks and investors, but serve the broader economies and societies. What's good for JPMorganChase and Goldman Sachs may not be what's good for America -- or for China.